High Efficiency Real Estate Investing with PeerStreet

Some of the world’s most expensive real estate, displayed oceanside a few blocks from Peerstreet HQ

This Mr. Money Mustache blog recently blew past its fifth birthday. In real life, things haven’t changed all that much: I live just a couple of blocks from where I lived in 2011. We are still retired and yet busily employed raising one boy. Still have the same cars and the same level of annual spending.

But when looking back through the posts that relate to technology and personal finance, I’m surprised at how quickly things in the wider world have changed, as the explosion of these touchscreen computers we all carry in our pockets has opened up all sorts of new business opportunities. The world of software has grown and matured and polished itself massively, which means that things that used to be complex and specialized are now streamlined and used by millions.

Some of my favorite changes have been in the world of investing. Index funds and ETFs have become more popular and easier to invest in. High-fee, “I can beat the market” financial advisers and funds are losing popularity. And outside of this traditional world of stock investing, software has opened up many other ways to productively deploy your green paper employees.

Lending Club and Prosper have smashed up the traditional role of big banks and credit cards, and taken over the personal lending market. For over 3 years I’ve had $30,000 lent out to several thousand people via slightly risky personal loans, and you can watch the results in my Lending Club Experiment page.

But the latest and perhaps the most interesting change to me has been the opening up of the real estate market. Worldwide, real estate represents a breathtaking chunk of humanity’s wealth: in the United States, the figure is about $25 trillion, which is about the same as the value of all of businesses of our stock market combined. Real estate has created many millionaires and billionaires (and also many bankruptcies for those less fortunate), but until recently it has been a localized, insider’s game.

With the right skills and drive, you can master your local real estate market and build a very nice firehose of cash that will propel you to a prosperous early retirement*. But those of us without that particular personality trait, or those stuck in overpriced cities with terrible rent-to-price ratios, were left behind.

This opportunity has not gone unnoticed, and now there are companies springing up to make real estate investing easier as well. Companies like Fundrise, PeerStreet, Yieldstreet, Patch of Land, GroundFloor, RealtyShares, Money360, RealtyMogul, LendingHome, and any number of additional competitors have been popping up in the news (and in some cases sending me promotional emails) to compete for a share. And while I’ve been reading about them, I have found it difficult to separate the well-managed from the risky. Before writing about any investment for this blog, I need to learn enough to invest my own money first.

How Peer-to-Peer Real Estate Investing Works

Although real estate provides the sizzle of this new industry, it’s a little different from buying an office building or becoming a landlord. As an investor, you’re usually funding loans, which are then used to buy and improve real properties, and you get paid for doing so. But because you’re not competing in the well-developed 30-year residential mortgage market, you can expect to collect annual interest in the 7-10% range, rather than the 3-4% that mortgage securities pay their owners. This is a newer market, which means more uncertainty and thus more risk. How could I dive into it responsibly, without just blindly throwing money at something I didn’t fully understand?

How and Why I Chose PeerStreet

In a handy shortcut, I had been enjoying an extended email conversation since last year with a reader named Liz, who happens to be a San Diego commercial real estate banker in real life. She is highly technical and motivated and has been quietly excelling in that field since 1998. And as we talked through our financial and life strategies, she mentioned that she had started doing some investing with a company called PeerStreet.

Her justification for that choice was that the loans are structured in a safer and less speculative way. As an investor with this company, you are buying only first-lien positions in loans on conservatively valued properties, compared to other companies where you end up with “Equity” in larger deals. Equity is still a valid legal ownership, but the first lienholder is the first one to get paid back in the event of any trouble.

To illustrate the large difference between this type of lending versus unsecured consumer stuff like Lending club, I’ve had over $8,000 in loans go into default in my Lending Club experiment (and yet it’s still profitable because the interest rates are high enough to overcome the defaults). Meanwhile, PeerStreet has not seen a single loan default – zero – since its founding in 2013. The net return to investors is similar, but based on a much more stable pool of money.

After learning a bit about the industry from my friend Liz, I decided to just open a test account with PeerStreet and poke around.

The Deceptively High-Tech Founders

Former Googler Brett Crosby schools us on Peerstreet technology in their meeting room.

No sooner did I create the account than I got an email from co-founder Brett Crosby, who was already familiar with the MMM blog due to a motivated brother (also a tech entrepreneur and bike enthusiast) who keeps sending him articles. With this second conversation started, I figured I had a great insider shortcut to help me learn much more. From various conversations, news stories and a Lend Academy podcast interview with the other founder Brew Johnson, I came away impressed. This is not just a bubble-economy financial firm run by well-connected Wallstreet MBAs. Brett is a software entrepreneur who created an outrageously advanced web analytics system called Urchin which was bought by Google and is now known as Google Analytics. Then he spent the next ten years in Google working on Gmail, Chrome, Docs and Drive. I use every one of these products daily.

Brew Johnson simulates a moment of calm on the Manhattan Beach pier, just a block down the street from headquarters (this image from their website).

Brew Johnson trained and practiced as a real estate attorney, but discovered an entrepreneurial bent and could not help but see market opportunities in his antiquated field. But he’s really less of a lawyer and more of a complete Business and Finance Savant. During an extended late-night conversation with him I was charged up by a fantastic and deeply technical analysis of the US finance and debt system that ran at the speed of thought. There are very few people who can talk about this field with both passion and Spock-like logic at the same time. His technical justification for teaming up with Brett to start PeerStreet is simply “We just kept seeing this mis-priced risk, and had to do something about it.”

The PeerStreet Experiment

In the end, I decided that this was worth an Official Experiment, so I planned a roadtrip with some interested friends (including Liz the commercial banker) to visit their office in Los Angeles. I also funded my account with $10,000 and made plans to put it to work during this in-person meeting.

A portion of the PeerStreet team poses on our meeting day, with Mustaches they had provided for the event (they must have figured out that I hate serious pictures).

After a great string of interesting conversations and meeting many of the people who develop the PeerStreet system, I set my account to “automated investing” mode to catch a fresh batch of new investments as they came out on that Friday morning. I had configured my account to invest in $2,000 chunks, into deals that that were on the high side of their conservative risk-return spectrum. I ended up with shares of five properties, similar to this one:

The short story is that I’ll be collecting interest on this loan at a rate of 10%, until 11 months from now when the loan is suddenly repaid in a balloon payment.

In more detail, what happened is that some time ago, a local real estate fix-and-flip specialist in Florida probably spotted this house for sale at a huge discount. Maybe it was a foreclosure, or storm damage, or some sort of auction for another reason. As an experienced project managing investor, this person needs quick, reasonably priced loans to allow them to buy quickly, deploy a work crew for renovations, and then put the house back onto the market at a higher value. The house fixer turns to a bridge lender (also known as “hard money lender”) for this type of loan.

Bridge lenders specialize in understanding which fix-and-flip specialists will actually make money, because this is how everyone stays in business. They fund the loans in exchange for a slice of legal ownership (a lien) on the house. But to grow their business more quickly, they can bring in money from other investors who are willing to buy a portion of these loans in exchange for some of the earnings. It is this role that PeerStreet (and by extension me, as a customer) plays.

There’s a lot under the hood at PeerStreet – there is automated statistical data analysis, but also real estate and loan experts on their staff who must do some manual verification and independent appraisals before these loans flow into the system. I’m glad I don’t have to do that job myself, but as an investor the experience is quite pleasant.

So Then What Happens?

The idea is, I put in some money and let it grow via these interest payments. As the interest rolls in and loans are repaid, I can choose new projects to fund, or have PeerStreet automatically deploy it for me. Or I can have the interest payments sent to me as a source of retirement income. It compounds over time, and we all get to decide if the investment is a worthwhile competitor to, say, a Real Estate Investment Trust, or stock investing via index funds. If anything unexpected happens, I’ll be sure to document that as well.

How to Keep Track of my Investment

I’ve created a new page called The PeerStreet Experiment, which joins similar ongoing investments I have going with Lending Club and Betterment. I’ll keep this up to date on an occasional basis, and it should become more interesting as time goes on and we hear from other fellow investors.

How To Invest Yourself

Like many peer-to-peer platforms, PeerStreet is bound by the rules of Securities and Exchange Commission which insist that only “Accredited Investors” (over $200k of income or $1M net worth) can invest – for now, at least. If you fit into this category, you can simply visit PeerStreet.com and create an account. Read everything on their frequently asked questions page to get the full technical and security background.

And if you still have more questions, type them up in the comments section below and we can invite the relevant people from Peerstreet itself to join in and answer.

Note: I have no affiliation with PeerStreet and so will not benefit financially if you happen to invest with them. As with all posts, this one was done only because I found the company interesting. If they did have an affiliate program I would probably join it (see the blog’s Affiliate policy), but in this case they do not.

Further Reading:Lend Academy maintains an enthusiastic and technical coverage of the peer-to-peer lending arena.

A May 2017 Update/Bonus

If you’re interested in trying out some investing with PeerStreet yourself, I have negotiated a special offer with the company where they give a double signup bonus to you (two 1% yield bumps), and none to me. They are trying this out as a limited test.

(I still have no affiliation with the company, but figured having the only site where this better offer is available might bring more people to my blog.) – here’s the URL for the double bump offer:

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Interesting, but I still like to buy properties myself. I have 16 rentals now, 15 in Colorado. The market is so crazy here, I think I am going to sell a few and reinvest in another state. Still a great place to flip though, I have 12 flips going at the moment.

Mark, I’m definitely a fan of owning real estate as well. However, I’ve also always loved hard money real estate loans and trust deed investments because of the short term nature and safer position in the capital stack that they provide. We’ve gotten a lot of anecdotal feedback from real estate investors like yourself who think certain markets they deal in are too hot to touch and look at PeerStreet as a good place to park money while waiting for opportunities to come up in their other real estate investment activity.

Brew – you mention certain markets as “too hot to touch” for some. I stumbled across this cool interactive map from the Washington Post, which shows real estate appreciation by zip since 2004. Their thesis is on racial neighborhood inequality, but is also shows what’s still “bubbly” (e.g. Manhattan – up 144%!).

“In this series, we examine the stark patterns of inequality in four cities — Stockton, Calif., Atlanta; Charlotte; and Washington, D.C. — that illuminate some of these differences. Even as homeownership remains a common American dream, a home is an asset that divides us.” Did the authors seriously just figure out that location matters in real estate? This is supposed to be a revelation, and apparently something that needs fixing? Absurd.

“The findings of The Post’s analysis underscore another way in which the economy, despite its improvements over the past several years, continues to deliver better returns for some Americans than others.” There are good investments and bad investments, who knew??

“While a typical single-family home has gained less than 14 percent in value since 2004, homes in the most expensive neighborhoods have gained 21 percent.” Is the argument that home prices should always steadily rise? This sounds like a kindergartners view of the stock market. Imagine how many more people would be homeless if housing prices always rose and never corrected, eventually we’d all be priced out unless we had rampant inflation.

It’s a nice map but some of the data is wrong and you cannot navigate using the map. New York can’t be searched by zip, LA doesn’t show up on the map graphics (most homes up 151%). In the end, this is just a story graphic, not a useful tool.

Hi Brew,
For individuals like myself (earning $90K/yr, zero debts, $270K total savings/investments), who don’t qualify as SEC accredited investors, where can we invest in real estate similar to Peer Street?
Thanks!

Bliss88 I think we’re out of luck. I don’t understand why they would advertise that you can fund as little as $1000. Considering the qualifications, who would bother to invest that little amount at a time anyway? I would love to plug in to this though if I could.

IMO one needs a strong stomach, strong ego (and sometimes a strong back) to be a hands on landlord. Unless you hire a property manager (which cuts into returns) you can’t really travel with peace of mind.
When I liquidated a chunk (like 50%) of my stock portfolio for the downpayment on a second property here in Toronto, my money manger guy (don’t worry – uber low MER, 0.5%) thought I was CRAZY. Why would I replace nice low hassle stocks and bonds for tenants?
And now, 12 months into the reno (you know the old line “Fast, good and cheap. Pick two”), waking up at 4am fretting about counters, and floor finishes and how I am going to pay the builder until I can start getting some rental income….I am starting to agree with him.

I’m a hands-on landlord (landlady actually). It does take a specific skills set, but anyone can learn those skills. Been managing my own property for 5 years now, previously I employed a property management company but I took it over to make more money and have more control. Oh boy was there a learning curve, but like any investment, the longer you are in (generally), the better the return on investment. Check out and study a dozen or so books on property management from your local library and half dozen on assertiveness skills and you should be good to go! And never (ever) negotiate with a new tenant on security deposit, pet deposit, or first month’s rent or you will be negotiating with that same tenant until they wear you down or you evict them for non-payment.
Hang in there; get your ad up on craigslist for a renter and you’ll soon see rent checks pouring in.

Hi MamaTeresa! As a soon to be landlord do you have a specific book you might recommend about landlording? It will only be one house but I still want to dig in to this as prepared as I can be. Thank you!

Hi-
I have been landladying for 4 years and really enjoy it. This book helped (helps) me: “Landlording: A Handymanual for Scrupulous Landlords and Landladies Who Do It Themselves” by Leigh Robinson. Also helpful are books on tenant law that you can get for your specific state if you are in US. Nolo Press is where you can find California Tenant Law. Also, if you are in California, the California Apartment Association (caanet.org) is fantastic. Great resources, up to date forms, advice line, etc.

If you’re an accredited investor, you can invest with Yieldstreet, which has short term, diversified real estate loans that yield about 9%. I’m admittedly a new investor, but I did quite a bit of research into other options (including PeerStreet). What sets Yieldstreet apart in my mind is that the properties have about a 50% loan to value ratio, which means you have more equity to fall back on if something were to go wrong. The platform isn’t perfect, and it suffers from a lack of available investments, and a fairly long processing time to deploy money. I wrote a more in-depth review on my website if anyone is interested (no affiliate links–just my opinion after a few weeks of research).

When you look up VGSIX, the yield is listed as only 4%, which would be low for a REIT unless there is some magic behind the scenes.

Are they reinvesting the cashflow from the underlying funds to create more capital appreciation? Does this make it more tax-efficient or do you still get a big taxable dividend report every year, even though the cash was reinvested before you ever saw it?

I think what Neil is saying is the price of the fund including dividends has averaged that much in that span. That fund pays out dividends every quarter to investors as any normal vanguard fund would. It depends how you have it set up, I have my portion of it in IRAs so I don’t get taxed on it, but I assume it would be the standard capital gains tax situation like most mutual funds if in taxable brokerage account.

The dividend is lower because the etf is market weighted. Larger REITS have lower dividend yields. The dividends are not tax advantaged (qualified). Treating buybacks as dividends, generally for stocks your long term return is = DivYield (including buybacks) + Diluted EPS growth , which is roughly DivYield (including buybacks) + (1-total payout ratio)*ROE. It is easier to find stocks with high ROE than high dividend yields. When a company invests earnings at the ROE, it is very tax efficient and ideal. ROE for REITS are obscured by depreciation, but you get the idea. Most of Buffet’s favorites have some dividend, low PE, and high ROE. REITS are usually less leveraged and so returns are not like Single family landlording with 75 LTV.

I wish I could understand this explanation but it’s too much for my Small Brain. Like MMM, I don’t understand why it’s been compounding at 11% yet paying dividends of 4%. If anyone can break it down into simple terms I would appreciate it. This product seems to suit my own tax situation really well and would help me diversify.

The first step is understanding return on assets (ROA) and return on equity(ROE). If you buy a building for $100mm and it returns 5mm after expenses, then the ROA is 5% plus 2% appreciation = 7%. But since this is real estate, we want to lever into it. We borrow at 4% at 50% loan to value (LTV). Our levered return (ROE) is (7 – 0.5*4)/0.5 = 10%. Each year, we keep some of the cash and reinvest the rest at 10% ROE.

Same thing with a stock. You earn the earnings yield (the inverse of the PE ratio). There are 3 things the company can do with it. Pay out in dividends, pay out in stock repurchase, invest it for you (at hopefully a high ROE).

See my other post below. Basically, the price grows proportionally to earnings in the long run. So you earn the dividend + diluted eps growth.

A stock trading at 15 PE, has an earnings yield of (1/15) = 6.6%. You put in 100 bucks and get a “payout ratio” of 80%. So the dividend is 6.6% * 0.8 = 5.28%. They take the other 20% of the earnings yield and invest it for you at the ROE of 10%. So eps growth (roughly price growth in the long run) is 10%*0.2 = 2%. So here we have a return of 5.28 + 2 = 7.28%.

I believe the reason the dividend returns are only 4% is largely because the fund values of the underlying REITS have been bid way up due to QE. Everyone is looking for yeild so these REITS are in a bit of a bubble. IF we raise interest rates, the fund values will drop and dividends will return to a more normal about for REITS around 5 to 10%

Regarding the “low” yield of Vanguard REIT (~4%): I think part of that is a function of them only investing in equity REITs , that is funds which owning and operating properties directly. It excludes mortgage REITs.

Mortgage REITs tend to yield much higher, and seems to operate in the same space that I understand Peerstreet does. The ishares mortgage REIT ETF, REM, yields closer to 9% for example.

The big caveat is that you shouldn’t only look at yield when comparing an investment. Here is the total return chart (equity + dividends) over the last two years for REM (orange) vs the Vanguard ETF, VNQ (blue):
Image link: http://i.imgur.com/PQel7oB.png
Live chart link: http://bit.ly/2rx55Fn
(I also threw the total stock market return, green, and total bond fund, yellow on for comparison purposes)

Not to pick on REM, it might be a totally fine fund for different time periods and depending on your needs, but my point was yield doesn’t tell the whole story, need to look at total return and the fundamentals of the investment.

Hopefully nobody minds this late comment reply, I’ve been doing some research for my own purposes when I came across this post and comment, it was a good chance to keep learning about REITs and similar investments.

Very interesting stuff! As I was reading I was getting exited about investing with PeerStreet until I saw it is only for accredited investors. Any idea of when it will be open to non-accredited investors?

You can always just lie.
The whole “accredited investor” requirement is something the government makes them do so that people who don’t know what they’re doing don’t get sold bad/risky investments. It’s a consumer (investor) protection thing. I think as long as you don’t complain to anyone if the real estate market tanks, no one cares.

I feel like you may be right but it may matter for tax purposes, no? Because you’d have to report any income from these to the IRS and since your income isn’t high enough these investments shouldn’t be showing up on your taxes…
I know its the SEC that has the accredited investor rule so if the two agencies haven’t set up any type of communication to tell the SEC about people braking the rule it may not matter.
Also is there a penalty for investing in something that’s only for accredited investors if you aren’t one. Like what would happen if you got caught by the SEC? My guess is, the answer may be nothing.

Jake,
Good question, but no, whether or not you are an accredited investor ( or lie about it), has no tax consequences.
As Matthew pointed out above, it’s a rule designed to protect unsophisticated investors from investing in products they don’t understand, with the assumption that if you meet the income or asset minimums you don’t need as much protection as a small investor.
Because the disclosure and registration requirements are MUCH less onerous if a securities issuer/ company offering an investment, offers it only to accredited investors, many investments are offered only to them. If Peerstreet were to offer its product to non accredited investors, its costs would go up, to at least some extent.

I agree and can’t believe how well we have done with Vanguard over the years of slow but steady growth. We are in the most conservative investments as well and did not expect a big pay off, only keeping pace with low inflation. Nice to be pleasantly surprised with better returns than expected.

It is ironic, isn’t it? Fannie and Freddie were letting strawberry pickers earning $15k a year “qualify” to borrow $720k during the housing boom, but the SEC won’t let somebody with a pretty decent income and more than a 1/2M net worth invest with PeerStreet.

Actually, the accredited investor status is not there to “ensure only the rich get richer.” The purpose is to protect people who can’t afford to lose their money from risky endeavors where they could lose everything. Most investment opportunities that require investors be accredited have a very non-trivial risk that they blow up and the investor loses everything. For the Average Joe with a low salary and low net worth, this could be catastrophic, but the SEC figures if you make a lot or have a lot of assets, you can afford to lose a lot of money.

What you said makes perfect sense. I tend to agree, but find fault with the uneven application of that principle. The list of risky investments that could wipe out someone of modest net worth are endless, but nonetheless available to them.

Fair enough. I think generally there are other safeguards in case for some of those (most brokerage accounts I know of require you to apply and get approved to be able to trade on margin or with options/futures). Not sure if there’s anything to slow down an investor who wants to buy unlisted OTC stocks since I’ve never looked into those. But you’re right that generally speaking, if you want to foolishly wipe yourself out in an unwise investment, you can find a way to do so ;)

Requiring to be an “accredited investor” is quite silly. I understand they are trying to protect low income earners in case these investments blow up… But why can I go to Vegas and bet my life savings on black in roulette, but not join other investors in a speculative investment? There needs to be a “I understand the risk” type of thing to sign, and thats it.

It is a bit of a silly way to discriminate, but the idea is that these types of things are harder to evaluate the risks of than better known instruments. Like, what is the repayment order in the case of a default? What are the market forces that would cause this to cause losses?

Accreditation requirements make a bit more sense in things like startup investing, which are super risky, and you need a lot of cash deployed to get any hits at all.

While I can understand this train of thought, I don’t fully agree. I have no where near $1 million in total assets but I do have a a decent combined income with my spouse, a very modest home with a tiny mortgage and actually enough invested in Vanguard currently to pay off said mortgage. I have 0 credit card debt and save a “car payment” a month since we always pay cash for our cars. We also fully fund all our retirement accounts and have a rental property. I think that it is absolutely ridiculous that the government would be just fine with me going out and buying a new $70,000 pick-up truck that will in 10 years be worth almost nothing – in fact encourages me to do so to help the economy, but is not okay with me taking 10 grand of out of my extra savings in Vanguard to try something like this. I cannot follow this line of reasoning.

It’s an arbitrary barrier to entry, lottery tickets are a terrible investment, but we let poor people buy those. Government is not equipped to protect people from their own stupidity, the SEC should be concerned with fraud, not with how people choose to invest.

It is a bummer, but we have to comply with SEC regulations and most of the rules that have been passed regarding non-accredited investors don’t apply to PeerStreet. I wrote a reply above about PeerStreet’s ethos of leveling the playing field between Main Street and Wall Street and we intend to provide access to all investors as soon as possible.

If you create an account and check that you are not accredited on sign up, we’ll make sure to notify you when our investments become available to everyone. Otherwise, keep track of us on your own and we hope to see you in the future.

Thanks for this feedback, Brew. I am sure there are millions of us who fall into the “non-accredited” category, yet are competent and savvy money managers with large chunks of cash to invest. I look forward to the day when the rest of us can join the fun – hopefully soon!

Maybe soon even if there isn’t anything PeerStreet can do from its end.

“In a 347-8 vote Monday, the House approved legislation that would expand the definition of an accredited investor. Under current rules, a person must have a net worth of $1 million, not including the value of a home, or make $200,000 or more annually.

So someone who was a landlord, or real estate agent, could qualify if the new recommendations fall into place. Wonder if renting out your place for a week while you are on vacation could make anyone qualify (as a landlord) as long as you report it as income on your taxes.

Hello MMM – Thank you for your insight. I’m a fan and appreciate what you do. I’m an insurance professional working in NYC and have been thinking a lot about my own exodus from the commuter, corporate lifestyle. I’ve been loosely researching RE investing for a while, and deciding whether to purchase a fix-and-flip or rental property myself, but this idea of PeerStreet is intriguing. My question is whether you view this as a replacement for a hard RE property investment, or as a supplemental investment? As far as risks are concerned, what are the downsides to investment? It seems PeerStreet has a good track record itself, but have they disclosed how many investors have had negative returns, and what those losses look like?

The discussion on RE as an investment vehicle on the forums is very wide, and deep – you might do some searching there for more information. Owning rentals in your city, in remote cities, investing in mortgage notes, REIT’s, etc. have all been discussion topics.

There are a lot of changes happening in the real estate market for investors. Locally, we have an investor group doing something similar by funding properties for flipping. I have seen several clients in my office using the program (on both sides) with success, including some of the founders. I have not invested personally, however. It makes me nervous. As a small part of your investment portfolio it can make sense. I look forward to your results, Pete.

Brew, correct me if I’m wrong on any of this, but I do a lot of passive real-estate investing through a syndicator and the K-1 is usually an administrative headache for the company (such as Realty Shares), but it is super easy and incredibly beneficial tax-wise for the investor since you can usually show a paper loss every year due to depreciation. Granted, those investments are structured much differently than yours (as you mentioned), in that you are actually a partner in an LLC that owns the property.

Am I correct in assuming that in your model, the investor simply receives interest in his or her investment, but is not in any way an owner of the property, so the 1099-int is taxed as ordinary income and you cannot claim any depreciation?

Doctor K, I have to start by saying: I am not an accountant and this is not tax advice, but from what I understand, when a K-1 is issued, it means you are investing in a partnership or LLC that owns an asset and the economics of that investment are passed through to members of the LLC. Equity investments do have depreciation, but loans do not, so with loan investments, there is no benefit to receiving a K-1 versus a 1099.

Because we made a decision to do only debt and no equity (which is largely due to equity being riskier than debt, but also because we felt there are lots of ways to invest in equity, but no great way to invest in real estate loans) and because we want to make it as easy as possible for investors to diversify, we structured PeerStreet very differently than other platforms, which makes 1099s the only option.

Finally, many investors find 1099s preferable for practical reasons, especially if you want to diversify across loans as managing a bunch of K-1s at tax time can be a nightmare and there are other potential costs of managing an LLC that owns loans and the K-1 process that could potentially drag down returns to investors, as well.

Got it–I agree and all of that makes sense. Very cool and original business model!

To MMM and the other readers, I would just point out that the first portion of the original post is a little confusing because it talks about the benefits of real estate investing and then makes it seem like you are investing in real estate with PeerStreet, and that companies like “Fundrise, PeerStreet, Yieldstreet, Patch of Land, GroundFloor, RealtyShares, Money360, RealtyMogul” are all similar companies that you could choose from to do that, but that is (obviously unintentionally) misleading. Investing in PeerStreet is profoundly different than investing in real estate through a company such as Fundrise, RealtyShares, or RealtyMogul for example. Not saying one is better or worse, but just that they are totally different. PeerStreet is much more similar to something like LendingClub or Prosper.

Hey Doctor K – thanks for clarifying that. I have a ton of passive credits I carry forward each year and am trying to find a way to generate passive income to claim some of these back. It looks like you’re pointing out that with PeerStreet I would not be able to. Do you have experience claiming passive income activity through any of the other companies you mention? Thanks so much!!

Ultimately, are they just a bridge loan financier? I’m still confused as to how it all works. Do they employ real estate agents who evaluate homes and give them a thumbs up or down for investment potential?

Hey Chris, we aren’t the direct bridge lender. Instead we work with existing lenders who have experience making bridge loans, then we vet loans using a combination of data analytics, manual underwriting and boots on the ground valuations, then make the loans that meet our underwriting guidelines available for investment on PeerStreet.

Our theory is that there are expert bridge lenders throughout the country that make quality loans, but there’s been no easy way for investors to access those loans. Additionally, there’s been no way to diversify across these loans.

Our goal is to surface high quality loans from many lenders, vet them, and make it easy for investors to spread their capital across loans to create diversification in a way that hasn’t existed before. We then manage the loans on behalf of investors, so investors can get the benefits of being a lender without all the work.

Ha! Great question(s). The bridge lender does the first layer of vetting and underwriting, commits their capital to make a loan, then we add a second layer of underwriting and vetting to the loans before they are made available for investment on the platform. So the loan, borrower, etc., must pass both the lender’s underwriting and PeerStreet’s independent vetting. We think our role as a double check is important and removes a potential conflict of interest if our business was based on originating loans to distribute to investors.

There’s a variety of things we do to try to ensure lenders from getting sloppy and keeping interests aligned with end investors… can’t get into all of them here, but they include everything from a thorough due diligence process on each loan, to comparative data analytics on performance versus other lenders, to greater transparency than has previously been available to investors.

Thanks for all of your responses. I see some posts balking at the 10% interest rate as being too high, but I don’t think it is at all. My father is addicted to refurbing homes and has about 20 rental properties. He has a hard time getting financing for purchasing foreclosures, even though he has 30 years of successful history. Once he refurbs them he can quickly get a mortgage, or sell, but he often uses a credit card as a bridge loan. Sounds like this could be a better option if he qualifies.

From an investor side it seems pretty cool as well. It opens up the entire country’s real estate market to investors in a way. Expands your reach as an investor.

Pretty cool business concept Brew & Brett. This is a great example of the P2P FinTech revolution we are experiencing. Awesome to see you take something previously unavailable to people and putting it in the eventual reach of the masses. Definitely a cool way to take part in an area of real estate that’s not normally part of everyone’s strategy. I’ll keep you guys in mind for anyone that might be interested.

A lot of people here are commenting about the risks. Risk is part of every transaction. No investment is 100% safe. Not that I advocate taking reckless risks, but this is another tool for people to consider in their overall investment strategy.

I do have one question. Obviously an investor through PeerStreet can decide based on a variety of factors to choose which loans to invest in such as property type, region, risk profile etc. But does PeerStreet take any behind the scenes risk management steps to ensure it doesn’t get overly exposed to a specific region, property type, or risk profile etc? In other words how is the composition of what you offer monitored? Thanks a lot to MMM, Brew, and Brett for this post.

Interesting business plan they have, thanks for bringing us some insight. It will be interesting to track your portfolio. I personally would be a bit nervous, I would have to understand it a lot more. Sounds like you had a pretty good diligence session with their team though so that probably helped you get comfortable.

As a banker, where I get nervous is that you are lending money at about 10%. As an equity holder, you would expect those kind of returns. As a first lien debt holder, you would expect a much lower rate. So the fact that some borrower is buying the RE property and getting a loan through PeerStreet at 10% indicates they have no other option for financing and would be a pretty risky borrower.

Good returns if the market holds up, but the real question is how it will perform in a down market. That’s when the rubber meets the road. I would like to think it would hold up well because you are a first lien holder (rather than equity), but how credible are these borrowers and how well do you understand the RE market and your ability to sell the property in foreclosure scenario in a down market?

But like I said, it will be interesting to track your performance. Thanks again for the insightful post!

As an investor with Peer Street, you are NOT a first lien holder. PeerStreet is the first lien holder. You hold unsecured notes issued by PeerStreet that are “linked” to the underlying first lien, called MDPN’s, or Mortgage Dependent Promissory Notes. The folks that hold the lien position take their cut and sell these notes to you at a LOWER interest rate than they receive. Read the FAQ’s and tell me your risk is adequately compensated by the first lien holder.

Another Reader, that’s true that investors on PeerStreet receive Mortgage Dependent Promissory Notes that are linked to the underlying mortgage.

It should be noted that this is similar to the structure that investors on LendingClub and Prosper receive when they invest on those platforms (called borrower dependent notes), with some key differences: namely, the underlying loans on PeerStreet that are linked to the MDPN are secured by real estate and those loans are held in a bankruptcy remote entity that holds the loan on behalf of the MDPN holders.

It is true that this structure is different than owning the first lien mortgage directly, however, the structure means that loans are effectively secured for investors and has some practical advantages over owning loans directly: namely, this structure is what enables investors to invest in very small increments in a loan.

This means investors can spread money across loans and diversify much more broadly, which we believe is an important risk mitigant that isn’t available in direct mortgage investments.

Additionally, because investing in a mortgage loan directly (or making a loan directly), requires a great deal of underwriting, legal compliance, management, sourcing, etc., making a direct investment can actually be risky for investors who don’t have the required expertise, which is why many investors would rather have PeerStreet handle that for them. Our goal is to take all of the legwork off the plate of investors, so they can make decisions based on their desired risk and return.

For the work we do, PeerStreet takes a 1% fee from payments made by borrowers as they repay the loans, alongside the investors in a loan. This structure may not be for everyone, but for investors who would like to get most of the benefits of being a direct lender without all the work, it seems to be pretty attractive. And I should note, even experienced lenders like Liz (who intro’d MMM to us) love the model.

I’ll reiterate what Brew said and respectfully disagree with The Green Swan. I have been in the lending industry a long time and 7-10% rates are what I have seen on these type of investments historically. Residential mortgages have much lower rates but they are a completely different financing vehicle than a bridge loan. Peer Street charges a fee but it’s disclosed in the information about the property and seems quite reasonable given the “service” they are providing.

The Green Swan, that’s a great point about the equity like yield on a first lien debt position and the borrower quality. High interest rate loans often means hair on a deal (either with the property or the borrower), however, many times it comes down to speed and timing.

For instance, even the highest quality borrowers in the fix-n-flip or rehab lending arena will pay high interest rates on short term loans, because when they find good deals they need to move very fast or they’ll lose out on a deal, and paying a high interest rate for 6-12 months is cheaper than giving up equity and upside in a deal (their business is very capital intensive as well, so having access to lending is important, even for sophisticated borrowers).

Your question on what happens in a downturn is also a great point. In addition to other safeguards, we think the legal structure we have employed that gives investors a way to diversify broadly across loan investments in very small amounts should mitigate risk in a downturn, especially when compared to other type of real estate related investments.

High quality borrowers? Are we talking about the corporation that was originally created for another purpose where the guarantors and 50 percent owners of the corporation have credit scores in the mid-500’s per the listing on your website? Those are some premium borrowers. That was a three month loan with two, three month extensions. The borrowers are one month into the second extension. The property is listed, but was never finished per the pictures on the MLS.

For this, the originator charged 10 percent. Must have been a nice origination fee to make up for the rate. Per your website, a third party is taking one percent and you are taking one percent. The investor in this quality paper gets 8 percent.

The property was appraised at 1,830 SF. The listing shows 2,500 sf. Maybe the unfinished space is included. I dunno, but I’m going to have a look at the place tomorrow. Still showing active tonight, on page three of the listings in that zip code.

AR, your eye for detail is appreciated here, but some of these comments are coming off as a bit sarcastic or condescending. If it helps, remember we’re in my living room among friends and we have a long history of mutual respect with our visiting entrepreneurs.

If you have suggestions for how to improve the PeerStreet system, or suggestions for comparable investments that you think are better, great. We’re all just here to learn something.

MMM – I’ve started to think of my fellow MMM readers as a friendly and team-oriented peer group. We are thoughtful and kind to each other as we each learn in our own ways. It is heartwarming to see the ways that you build and reinforce that sense of community. And, this article focuses on an absolutely cool and disruptive idea.

AR, your comments are appreciated, but I feel like you may have read my previous answer out of context. For instance, above I was responding to another reader’s question regarding why someone would pay a high rate on a loan. My answer was:

“High interest rate loans often means hair on a deal (either with the property or the borrower), however, many times it comes down to speed and timing. For instance, even the highest quality borrowers in the fix-n-flip or rehab lending arena will pay high interest rates on short term loans.”

I never said that all borrowers on PeerStreet are high quality by traditional standards. We do however, take into account borrower quality and if the borrower quality is low by historical standards, there must be mitigating circumstances present for a loan to qualify. The loan I believe you are referencing above, raises an interesting question… the borrowers on the face would clearly have hair on them, as their Fico’s are low by historical banking standards. In a case such as these, there must be mitigating circumstances for the loan to pass our underwriting. In this case, the lender who originated the loan has had experience with this borrower, and has agreed to take a junior position to PeerStreet investors as a risk mitigant (meaning that if the borrower were to default, the original lender would lose capital before PeerStreet investors were impaired). Because PeerStreet is comfortable with this lender as a counterparty, and love it when lenders are willing to stand behind their underwriting by putting their money in a first loss position, we found this mitigation enough to offsite the low Fico score of the guarantors.

Obviously we don’t expect investors to like every investment available on PeerStreet, and many investors won’t find PeerStreet appropriate for their needs, but we do run loans through a thorough process before making them available, but the whole story that goes on behind the scenes isn’t always easy to show.

Because of legal and privacy reasons, we are limited with the information we can share publicly, especially on a forum outside of PeerStreet like MMM, but I’d be happy to answer any questions you have directly if you reach out to feedback via PeerStreet.

The cool part about Peer Street is that you can see the FICO score of the individuals involved, read the synopsis on the deal, do your own research, consider if the other aspects of the deal actually mitigate said FICO and then decide if you want to lend on that particular deal. You create your own set of lending rules on Peer Street based on your own critical thinking and logic. Many of the deals feature Principals with FICO scores well in excess of 700 so it’s not like they are focused on “subprime” real estate investors. To me, this is a little like investing in REITs but the returns are a little higher and I have more of a choice in the investments and can filter on geographic location, type of property, FICO scores and loan to values. REITs have a pile of properties all bundled together with perhaps a particular industry focus but this type of granularity in the details is not available. Just my two cents.

This is good additional info that I wasn’t aware of. I appreciate the follow-up. I also did not fully appreciate the existence of such a niche market and area to lend. But to your point, there has to be a fair amount of hair on these deals given the high interest rate and presumed lack of traditional financing for such borrowers (i.e. a bank). I would consider such an investment vehicle myself if I had more time to analyze and research (and that day may come, but too busy right now) for just the sake of diversifying from my current portfolio and for the potential of strong returns.

One major question would be what recourse you have to the borrowers themselves? Is the only recourse the property, or are there any guarantees, etc?

Checked into both of these, they both have severe limits on unaccredited investors. For Fundrise the properties you can invest in as an unaccredited investor are very limited while the majority are only for accredited. Groundfloor only allows unaccredited investors from 8 states plus Washington DC. Didn’t bother looking into their offerings since I am not in those states. I’ll probably look into Fundrise some more because it holds the most promise for a person like me, but I have doubts they’ll have any good opportunities for retail investors.

I’ve been reading and getting excited about these new fintech companies for years. I was fascinated with the LendingClub model that seemed to jump start the industry. This excitement is now turning into more of a depression, since it will be a long time (if ever) before I get to invest this way. Being in PA I don’t even get to invest in LendingClub normally, despite it being a public company now. The irony is that for all of the usage of the word “peer”, the regulations effectively make it a “club”, and most of us ain’t in it. Most Mustachians probably won’t be able to participate until well after they retire, which may or may not be a good thing given the novelty and lack of performance history these investments have, but I’d still love to try.

Not to the Accredited Investor level yet, but interesting read. Makes me want to continue exploring peer lending, but more at the $100k/year and $250k net worth level :). Also just want to say “Hey, there’s Jesse!” He’s doing a great job putting a personal touch on YNAB Whiteboards/social posts, so much so that a regular user like me thinks “Wow, you know Jesse? I know Jesse!” Even though, I of course, do not.

Thanks for jumping in and checking it out for us. I think I will wait a bit too. I’m hoarding cash in case of a stock market crash at the moment.
Real estate P2P sounds good, but the return seems a bit low. I also want to see how they do in a down cycle. Everyone can make money when the tide is rising. I hope they don’t crash and burn when the real estate market goes down.

Joe, I totally agree about the rising tide. Brett, one of my co-founders, can tell you my two favorite quotes are Warren Buffett’s “Only when the tide goes out do you discover who’s been swimming naked” and someone else’s “More money has been lost chasing yield than at the point of a gun.” Only time will tell, but we think we’ve taken a more conservative approach and structured PeerStreet in a way that is well positioned for a down cycle.

this sounds like financial alchemy.
I must be missing a step here.
how do you earn 10% on your money when mortgage rates are low (if anything like here in Canada somewhere in the 3% range)?
what is the borrow paying?
you don’t get a 7% premium for nothing.

The local club in my area providing funding do so with a higher interest rate. In most cases they get a piece of the profit as well. People without borrowing resources can buy and flip properties using this funding resource. I’m guessing this works in a similar fashion.

You have captured my interest. The only hesitation I have is how the interest is taxed. We have money I both lending club and prosper and do quite well however we end up paying a huge amount of tax on that money at the end of the year. I’m assuming that this is taxed the same way. Taking taxes into account, do you find that it is still worth it to invest in theses peer to peer investments over socks? Just curious. Thanks for the careful analysis!

Ditto! This is my question too. I’ve invested through RealtyShares and Patch Of Land, and they send me K-1 statements at the end of the year, so from my understanding the income from these types of investments are taxed at your normal rate and aren’t eligible for the lower capital gains rates. But I’m no expert. I would love to hear an actual experts take and offer a real-world comparison of the net amount earned after all is said and done.

Would depend on your marginal tax rate. In general, investments like these with required distributions (either through interest payments or dividend payouts) are probably best held within retirement accounts where they are tax-sheltered. According to their website, PeerStreet allows investments through a self-directed IRA. I’ve never heard of these accounts before, but their model sounds interesting enough that I am actively learning about them!

Lena, I must start by saying that I am not accountant and please do not treat this as tax advice… but… tax treatment is similar to LendingClub and Prosper, however, there is a difference that some investors have noted makes PeerStreet/secured assets more attractive vs. consumer credit and that is the way gains and losses are treated. Gains on LendingClub and Prosper are treated as ordinary gains, but losses are treated as capital losses, meaning that you can’t offset losses on LendingClub and Prosper against the income gains, which reduces the effective yield and because consumer credit loans on LC and Prosper tend to have very high default rates and losses, this can have an impact on the overall yield and Because our loans assets are secured by real estate, default rates are much lower (we’ve had no losses to date), and this tax treatment quirk is avoided for the most part. Again, please don’t treat this as tax advice, but it is feedback we have heard from many investors.

This is why I do all my hard money in an IRA, since you pay ordinary income tax on IRA withdrawals anyway, and since you can actually live on income from an IRA with LESS TAX anyway even after paying the penalty.

Our mutual friend, Jesse, brought PS to my attention a couple of weeks back and Brett reached out to me. Citing time constraints I put him off and asked him to ping me again a few weeks down the line. He graciously agreed.

With your post I now have a much better understanding of what to expect. And a much keener interest in the coming conversation!

I remember seeing the idea of crowd-funding real estate proposed on the Shark Tank TV show a couple of years ago. Sounds like PeerStreet has been able to figure out how to do this well. But I can’t help but wonder what happens if and when the hard-money lender market becomes saturated? Just thinking through the basics of supply and demand, you would think eventually there would be enough investors/hard-money lenders willing to lend money that the borrowers get to pick and choose the lowest rate which in-turn would drive down the ROI. Very similar to the way prospective home owners shop for mortgages rates nowadays. Either way, I still think this is a cool idea and may be a way to diversify investments. Thanks for sharing. Looking forward to the experiment.

So you decided to use $10,000 on the experiment and use $2,000 allocations. Did PeerStreet have any recommended minimum capital or allocation value? I’d think $50,000 with $5,000 allocations such that any one loan doesn’t represent more than 10% of the capital… probably would feel better with 100k & 5k allocations 5%/position.

Just curious about your thought process on the total capital and allocation value. Thanks!

If I knew in advance you were riding a Tesla to PeerStreet from Longmont, I would have asked to join the ride especially with YNAB in the car.

I worked on some radio spots for one of the companies you list at the beginning of the post. In essence, the appeal to prospective investors is identical to the benefits you list in your post: Access and diversification via technology. Technology simplifies investing in real estate, giving you access to deals you never had access to before, deals vetted by industry experts. It makes it faster and easier to diversify through geography, type of property and type of asset … The ads they ran tended to emphasize the democratizing power of technology, saying things like “Technology doesn’t care what country club you belong to, and it doesn’t keep banker’s hours. The real estate industry held out against technology long enough. But technology won.” etc. etc. The owner of the company is course aware that it won’t truly be democratizing until they find a way to give access to people other than the SEC’s “accredited investors.” I’m pretty sure that’s in the pipeline.

The underlying analytics sounds very interesting and being able to apply that in the Real Estate space has me intrigued. The track record of their leadership team and brains behind the technical platform looks terrific.

And before any reader snipey comments, I have absolutely no (zero, nada) affiliation with PeerStreet!!

I have swung back and forward on the value of REITs in an investment portfolio and whether they are a solid foundation or unnecessary clutter in your investment house. We are invested in two non-traded REITs, which carry different level of risk to a publicly traded REIT. Lack of liquidity, transparency of performance, up-front costs/commission etc.

Anyway, enough rambling. I am off to take a look at PeerStreet. Yes, the company may be early and risks are always there with stuff that is early…..ask anybody that has done Due Diligence on any investment on a tech-related company.

Essentially, but they likely have to go through a foreclosure process. I don’t think any hard money lender really wants that headache and they probably try to extend the terms if possible first. Question is how is the individual investor “made whole” in the case of a borrower default?

Andrew, in the event of a default, PeerStreet will work out the loan on behalf of investors. In the event of a foreclosure and sale of the underlying property, the proceeds from the sale (less costs to foreclose on the property) would be distributed to investors in the loan.

MMM, as always another great article (you just keep getting better and better!!!). One note, at the beginning of the article on the PeerStreet experiment site you say you started this in April 2015, didn’t you mean 2016?

Not to bust your chops by any means, just wanted to avoid confusion for others.

While I am not an accredited investor, this opportunity sounds very interesting. I would like to see what returns average over the course of a five-year span. I still like the security of reading through a prospectus on a mutual fund with a 25+ year track record.

Hopefully I max out my retirement accounts this year with a bit of extra money left over. This won’t be an option, but I may consider playing with the Lending Club. Sucks wages in Wisconsin are so much lower on average, feels like I’m at a big disadvantage being here in terms of extra cash to play with.

I am currently a Peerstreet user, and agree with MMM that PeerStreets platform is a great tool to diversify investments, and also agree that PeerStreet is superior to other crowd funding sites (which I have tried some of the others mentioned as well).
One exception being the requirement to fund your account, prior to the investment happening. In other crowd funding sites you link a bank account, and debit the funds when the deal closes. I don’t like the idea of having money waiting in the que for a good opportunity. And the best investments go quickly, so you have to have money in the account and ready in order to get in.
Another benefit is the current referral program. If you sign up by referral you get a 1% yield bump on your first investment. Making the return even better.

Lastly, I like the investment because you can pick the investments (although all options are already pre-vetted by professionals who know better than I). This little bit of participation makes me feel like I earn the higher returns than investing in an ETF.

Again, Thanks for the article MMM, and I agree that Peerstreet is an awesome investing platform.

John, the requirement to fund the account in advance is a big difference between PeerStreet and every other real estate related site out there. PeerStreet’s platform is more akin to an eTrade account for investing in real estate loans or LendingClub, where you fund into an account, then can easily allocate investments across loans, as opposed to investing in one deal at a time, signing docs and sending a wire or ACH individually for each investment. While pre-funding can seem a little different at first, especially when testing things out, it provides some significant benefits overall, namely the ability to click to invest in new loans easily, re-investing interest payments into new loans and setting up the auto-invest feature that MMM referenced.

Additionally, it should be noted that when you pre-fund your account via PeerStreet’s platform, funds are held in an investor trust account at City National Bank on your behalf (and FDIC insured while held there), so it acts as your own virtual bank account, then when you select your loan investments (manually or using auto-invest, we allocate your funds into the loan investments from your account). Like I said, the platform is more akin to LendingClub than other real estate related sites which provides for additional benefits to users.

Brew, is PeerStreet thinking about offering a good interest rate for the cash that’s held, via City National? Seems like an opportunity to attract a high volume of cash deposits if there was an above market interest rate in the parked cash account…which drives investment into the deals themselves.

I don’t get it. I pay up to a 1% fee. High risk returns generally lag long term S&P performance. Tax expenses are 2x equities (right?). Diversification? When in history has the real estate market held up as the stock market eats it?

Propertypartner does something similar in the uk for people over on this side of the pond, though from a cursory glance at their website I’m not certain you’d be first, second or 100th in line of creditors to get your money back if the SHTF

Investing with PeerStreet does not give you any interest in the property. Your note is NOT secured by the property and you have no right of foreclosure if you are not paid. Instead, your note is “linked” to the underlying mortgage. See the following excerpt from the FAQ on the PeerStreet website.

Am I investing directly in a property?

0
No. When you invest on PeerStreet, you will receive a mortgage-dependent promissory note, or “MDPN” that is issued by PeerStreet. These notes, however, are linked to the performance of the corresponding loan tied to your investment.

The ONLY way I would take on the risk of hard money lending would be if I had a first position lien on the property. Instead, these guys want you to accept a skimmed hard money yield from notes backed by the company. Mis-priced risk? Foreclose on a note and see if you think the risk is mis-priced.

My 32 years of real estate experience (vs. their 97 TOTAL years companywide of real estate experience) tells me to decline taking on this risk.

I went far enough through the registration process to look at the investments. There is zero possibility that I would write a check based on the information presented. Writing a check means you are willing to rely on their purchase of the originator’s loan as proof of a good investment and that they have turned around and fairly priced the offering to you after taking their cut.

It’s not necessary for a seasoned real estate investor to “sniff the dirt” to make a good investment. It is necessary to understand the product and the market. Buying unsecured loans using data analytics through Lending Chub or Prosper is straightforward. Risk is relatively predictable and the possible outcomes known. Credit card issuers have it down to a science. Real estate notes bought by inexperienced investors on the promises of interested parties? That’s an entirely different proposition.

This is the relevant part to your points above:
“PeerStreet also holds loans in a bankruptcy-remote entity that is separate from our primary corporate entity. In the event PeerStreet no longer remains in business, a third-party “special member” will step in to serve as a trustee to manage loan investments and ensure that investors continue to receive interest and principal payments.”

Regarding structure, all loans are held on behalf of investors in a bankruptcy remote special purpose entity (SPE), in a similar way to the way that financial institutions hold loans in a traditional securitization. The SPE has an unaffiliated special member that acts like a trustee for investors in the event PeerStreet’s operating company ever ceases operations. This structure provides multiple layers of protection:

1) Counter-party risk – because the SPE that holds the loans on behalf of investors is separate from PeerStreet’s operating company, if PeerStreet were to cease operations, the SPE’s special member would take over and manage the loans on behalf of investors.

2) Payment default risk by PeerStreet – the SPE has no material liabilities, and is *required* to pass through pro rata payments from the loans to investors as and when payments are received from borrowers. If the SPE withholds any payments, it would be a violation of its operating agreement, a violation of securities laws, and a default under its contractual pass-through obligations to investors in loans.

3) Borrower default – in the event of a borrower default, PeerStreet is obligated to proceed with foreclosure/workout on behalf of investors and distribute funds to investors, when recovered. We have significant workout/asset management experience on our team; this is very rare for firms in our space.

This structure is what makes it possible for investors to lend much smaller amounts than has been historically possible in this asset class, which creates economic benefits:

A) diversification across many loans instead of taking concentrated positions in a loan/loans, and
B) the ability to re-invest interest payments into new loans.

What you are doing is buying some or all of the loan from the originator and slicing it up for resale. The small investor gives up some of the yield to get the ability to invest at all. Makes sense at first glance. However, the MDPN’s are not secured by a lien on the property. Should you find it necessary to foreclose, you would no doubt charge the foreclosure costs off to the holders of the MDPN’s and any remaining first lien interests. You would make them whole to the extent possible with the remaining proceeds. Any net equity gained by foreclosure would come to you, not the holders of the MDPN’s. The small investor accepts a lower yield, pays his share of any costs, suffers equally in any losses and has no upside. Thanks, but I will pass.

I also don’t agree with you that hard money mis-prices risk. Working with dodgy flippers that may or may not perform, having to foreclose with no loan payments for months or even years, and rapidly shifting markets that can undercut the value of the collateral are all risks hard money lenders take. Looking at one of your flip loans locally, I see the borrower is a corporation set up for another purpose and the guarantors have credit scores in the mid- 500’s. Interestingly, the borrower is already on his second extension. And you want an investor to accept 8 percent for that risk? Most people here have no understanding of the pitfalls of real estate lending and just see the 8 percent return.

What’s quite clear to me from reading through the comments here is that some of your accredited investors have no idea of what they are buying and from whom. The person commenting above that describes the investments as “…all options are already pre-vetted by professionals who know better than I…” does not understand that you have no fiduciary or even suitability responsibility to him.

If you were offering your product to sophisticated real estate investors with market knowledge and experience, I would not object. Offering the product to “accredited investors” on the assumption they have sufficient real estate investment knowledge to evaluate the risk is absurd and just plain wrong.

I appreciate your comments. I too am concerned about the foreclosure process and the costs PeerStreet would recoup for themselves in the case of a foreclosure, while leaving the investor only the downside and no upside.

Imagine if you will a “half finished project”….With permits pulled but no finals….The “flipper” goes BK or to Vegas to gamble….Now… someone…has to foreclose and needs to go get the contractors….who haven’t been paid and have placed mechanic’s liens on the property to finish the work and get the project “signed off”….I have lived this nightmare and it does not end well. Any “flipper” worth his salt can find a good lender and set up a line of credit….I get letters/advertising daily….Hard money lending in this neck of the woods is 16-18% and there is a reason…risk….

Then don’t invest. The part you don’t seem to like is the part that I like. Instead of all of my eggs in one basket like if I did a spec loan for a builder or a flip loan for an investor I get to diversify across multiple borrowers in multiple markets. That’s worth 1% to me for Peer Street and 1%+ for an originator. Also – in the event of default – the originator and Peer Street both are motivated not just to get paid for themselves, but because instead of just one person losing money there are 100 people wondering where there payment is. Further – there is usually enough equity in the deal that another investor will pick it up (presumably). I just don’t see the flags you are seeing, but maybe I am more risk averse. This is Lending Club but secured vs. unsecured. I’d rather lend to an investor with a track record in a 1st Lien position then someone with a spending problem using a loan from lending club to consolidate credit card debt because they can’t tap into their home equity anymore.

You are correct, Allen. It’s just semantics. My understanding is that all the investors are in a Pari-Passu lien position, meaning that if the property were liquidated for $50,000 and the note was for $100,000 and there were 100 people with $1,000 invested, each person would receive $500 of their original $1,000 note. The difference between this and Lending Club is that there is no secondary source of repayment on those LC notes so once the Borrower defaults (and whatever amount of time goes by), the entire principle amount of the note is gone. Right now the returns might be similar to lending club but I think over the long term the Peer Street returns will be a bit smaller reflecting the lower risk associated with having a real estate secured note instead of completely unsecured consumer debt.

That’s correct Liz and Allen. It should be noted that costs to foreclose would be payable for sale proceeds first, then remaining capital would be paid out to investors. However, foreclosure costs would be present in a default scenario whether PeerStreet is involved or not.

A lot of investors feel the 1% fee is a good tradeoff for all the admin we handle, but some investors, especially those with a lot of lending experience, would prefer to handle everything themselves, which is totally understandable.

I think that those of us who have dipped our toes into other alternative investments will see management and other administrative costs on those with all-in costs in excess of 1% in many cases. The other thing is that those alternative investments may force the investor to tie up funds for 3-5 years or even more. The minimum amount that you could invest in that kind of entity may be $50,000 or $100,000. Alternatively, there are companies offering one-off trust deed investments/bridge loans all the time that will slice it up into different pieces but I haven’t seen one yet that shows me the big data on the real estate market and what happened to values in that zip code in the downturn or had an online portal where I could track my investments, transaction history and provided me the assurances that the loan funds would be properly administrated with the trust accounts. I stumbled upon Peer Street at a time when I was considering investing in one of these one-off real estate investments and couldn’t figure out how to get comfortable with it. Big picture, this is another way to invest our hard earned money providing a stream of interest income. It carries a level of risk like any other investment. The platform, however, allows investors to diversify the money they invest across several properties and the barrier to entry is much lower than on some other alternative investments. SEC requires that folks participating are accredited investors but other than that, if you have $1,000 to invest, you can start earning a stream of interest income. If you are like me and don’t have the stomach or patience to be a landlord and earn rental income, this is another way to diversify your total portfolio of investments. Furthermore, when I do retire, the mechanics of Peer Street may help with creating a more tax efficient stream of income. The income is interest income and taxed at ordinary income rates and when the principal on a note pays back, that’s not a taxable event. The note just pays back and I can either re-invest that money in other Peer Street investments, invest in the stock market or something else or use that money to pay my expenses. Note that I am not a tax professional but I see some benefit to short term interest earning notes with various maturities being part of the stream of income when I enter that phase.

Just a note – accredited investor requirements are $200,000 / year for a single income or $300,000 / year for dual income.

I do own shares in a hard money lender with a very nice dividend yield, but never wanted to invest directly in the notes. I don’t really have that much money invested with that stock either. Seems like investing in a fractional portion of the notes pushes too much risk onto you, while investing in the company itself decreases risk if they have been properly valuing loans they make.

Interesting stuff. I have been looking myself to buy a rental property in my neighborhood, but haven’t found the right opportunity yet. Unfortunately I don’t meet the income or net worth requirements, but I’ll have to check out some of the other sites. Thanks for the review MMM! Looking forward to seeing how this fairs against other investment vehicles.

Thanks for the deep dive on PeerStreet, I’m always looking for ways to diversify my investments.

There are definitely some interesting online developments in the real estate world. One that caught my attention is SideDoor (sidedoorinc.com). It looks like they are taking FSBO to the next level by providing all the supporting services a realtor would offer.

I for one look forward to this as I’ll be selling my home in the near future and I’m not looking forward to paying $27,000 in real estate commissions.

I would worry about the underwriting, and the next investment downtown. I have a little money with LC today, and it is going well, but I think I would want to personally be able to run numbers for any hard money loans. Too many clueless people in real estate who lose their shirts.

LuckyOz, we agree and try to give as much transparency as possible into loans, so if an investor chooses, they can do a deep dive and run the numbers themselves before making an investment (which we think is a good practice, especially when trying out PeerStreet).

Dear MMM,
I like the peer-to-peer lending model described here. But there’s something about flipping houses that makes my stomach flip. I live in Seattle — an out-of-whack housing market if ever there was — where flipping was commonplace before the housing market crash. It has become popular again, with seminars every week someplace. “Learn how to flip houses for a living.” Ugh. Seems like a business that adds no real value to society, but rather skims off the hard work of others. (Yes, a bit blunt, but not entirely off base, either.)

I fear Seattle’s real estate market is becoming a bubble again. Some house flips I’ve seen consist of people buying a house, spiffing up the kitchen and throwing some sod over a bad lawn, then flipping the place for tens of thousands of dollars (or more) than they paid. Yes, “a fool and his money are soon parted …”

Sure you can argue supply and demand, but this flipping business seems to be fueling a new housing bubble. I understand there exist good and bad “flippers,” but it seems to me flippers take advantage of both sellers and buyer.

In a market where people have a tough time finding affordable housing, the market is forcing people to buy homes far from the city center and often far from their work. Consequently, it’s turning them into disgruntled commuters on our already-clogged freeways. So biking to work? Not possible because of the distance. And Seattle’s a bike-friendly city.

I’d love to see a discussion of the social, cultural, and ethical effects of house-flipping.

Yeah, I was wondering about the same thing. It might be useful to separate the concept of overly hot markets (which I really don’t like because they seem irrational), from the practice of an investor buying a crappy house and fixing it up.

Here in my neighborhood, there’s a guy named Tom who has been buying completely unloved 100-year-old places, then working with a few elite carpenters for up to TWO YEARS on each one to rebuild them right down to the last piece of trim, detached studio/workshed and landscaped garden. He does great work and it is helping our neighborhood immensely. Very few people have the skills and resources to restore an old, neglected house, but there are plenty who have the money to pay well for one (and his creations are often over $500k when finished) that is ready to move into.

With a PeerStreet account, you have the option of looking into each project and deciding if it’s a socially worthwhile thing as well as financially profitable. There are a lot of details included with each investment. I find this kind of cool – just like how I send my Lending Club dollars only to people who are paying off credit card debt, not to those borrowing to finance a new car/boat/truck. Not perfect, but worth a try.

“just like how I send my Lending Club dollars only to people who are paying off credit card debt, not to those borrowing to finance a new car/boat/truck. Not perfect, but worth a try.”

You realize that this isn’t ANYWHERE near perfect because that field in the loan application is purely discretionary and LendingClub doesn’t verify it in any way (at least this is what I was told by LendingClub when I asked). I’ve been running the LendingClub experiment for about as long as you have, though with higher amounts, and higher grades of loans (A-F, mostly B/C/D) due to lack of availability of E/F/G.

That said, I also filter on “refi”, “pay off CC”, and eliminate all the others (“medical”, “renovation”, “vacation”, “car”, etc).

Thanks for your thoughtful reply and clarifying information. I completely agree with you about the overly hot markets being irrational. That’s surely the case with Seattle — all over agai! And Tom, the guy you describe, is the ideal “flipper.” In fact, maybe we need a new, more respectable name for someone who restores houses this way. Rather than building new cookie-cutter tracts of houses, Tom is carefully restoring old ones. That’s an admirable — and demanding — job. I just wish it was more common in Seattle. Every time I hear the ad on the radio for house-flipping seminars, I grit my teeth and change the station. I’ve seen too many of those rush, band-aid restoration jobs.

In order to qualify as an accredited investor in the United States, you must fall under one of the following categories according to the SEC:

1. You are an individual and earn an income in excess of $200,000 per year, or $300,000 per year jointly with a spouse. This needs to have been consistent for the past two years and you must reasonably be able to expect the same level of income going forward.
2. You are an individual who has a net worth exceeding $1 million, either individually or jointly, excluding the value of a primary residence
3. You are a general partner, executive officer, director or combination thereof for the issuer of the offered securities
4. A bank, insurance company, registered investment company, business development company or small business investment company
5. A business in which equity owners all fall under the category of accredited investors
6. An employee benefits plan, trust, charitable organization, partnership or company with total assets greater than $5 million

How does PeerStreet make its money? Do they charge a fee to you (the investor) or take it out on the other side? I couldn’t find this question answered in their FAQ. I’m surprised you didn’t ask / disclose it yourself, since you’re a big advocate of low cost ETFs/funds. High expense costs have been proven to be a major factor in the average investor under-performing, so when a newfangled investment doesn’t disclose their expense model it makes me very suspicious.

“PeerStreet may apply a servicing fee on each loan offered for investment. The servicing fee is a “spread” between the interest rate payable on a loan and the interest rate you receive as an investor. With this structure, PeerStreet has aligned our interests with our investors as we will only get paid when our investors get paid. Generally, this fee should be in the range of 0.25%-1.00% and it will always be disclosed.”

Another idea for nonaccredited investors is to view a steady buyback program as dividend yield. Why? Because it is effectively is. Let’s say there is a large insurance company with a PE (price earnings ratio) of 10. This implies an earnings yield of 10%. Meaning, with no growth, they could pay out 10% in dividends. But they don’t because many investors would prefer to not pay taxes on that much dividends. So, they pay 2% out in dividends and 7% out in stock repurchase and invest the other 1% at an ROE of 13%. Let’s assume this large insurance company stays at zero growth…earnings remains $10 on $100 stock price. The PE remains unchanged, since a 10 PE is typical for a no-growth, large corporation. So, holding PE constant and earnings constant, the price should change accordingly with the stock repurchase. I would argue that a safe withdrawal (including dividends) from such a company is well in excess of the standard 4%. Maybe 8%?? AND it retains the “qualified” dividend tax effectiveness! What if the company stops buying back stock because it wants to invest more in an ROE of say 15%? Again, probably a good outcome. Just some thoughts. Also, yes an insurance company like this exists, but I am not here to pitch stocks. I am sure there are other similar investments. Interested in other’s opinions.

To me, real estate is an attractive investment because you can get tax-advantaged, highly leveraged and exponential returns on investments that you control with a fairly low level of risk if you know what you’re doing. In that universe, flipping is probably the HIGHEST risk area unless you’re an experienced investor / developer AND you’re giving up virtually all of the tax advantages.

From a pure valuation perspective, underwriting in real estate is all over the place and can be complete BS. 75% LTV on a single family appraisal in a market I don’t know with a random developer wouldn’t make me feel all that great.

Additionally, the most telling thing to me in the Peer Street FAQ is the history of the originators. Not one of these loan originators has survived a financial crisis. In fact, virtually all of them started after 2012. What does that mean? This is hot money coming into a hot market and they’ll be the first to lose their asses.

Is risk mispriced for bridge loans? Probably. But peer street is basically securitizing the hottest of hot money. Nothing wrong with it while the sun is shining but ain’t one of these firms survived even one full real estate cycle.

So it’s interesting and I’d like to look into it, but on first blush, that aspect is not that appealing to me. Plus, I’m seeing hard money being lent in the 10% range right now, so we are nearing the top of this market as far as hard money pricing and terms. There’s not going to be a ton of meat left on the bone soon.

A lot of smart money that’s been around for 50 years is already falling all over itself to get the better developers and deals — guess what Peer street is going to end up with? Probably the crap that’s left over.

I could be completely wrong, but something to think about and I’ve been on the ground in three different markets in the past year doing deals.

To people’s points about overheated markets though, I’m just not seeing that yet. If the rents are equivalent or close to what it would cost to buy in your market, then your market is likely not overheated unless there’s a ton of supply coming on and not increasing demand.

In places like Seattle, NYC, San Fran, etc.. They may by hot but there’s no end in sight. You have supply constrained markets, never ending demand, and good income growth. If landlords are raising rents and easily selling out and those prices are close to what it would cost to rent, you should consider buying a place so you don’t get priced out of your own market.

If you’re already priced out, start looking at doubles or triples if they’re around. The cost per sq. ft on a multiunit will generally be much lower than a single and the high rents will reduce your actual carrying costs substantially given the low % rate environment we’re in. Then you can sit back and enjoy the appreciation instead of gripe about it.

DanielBorn,
I think you make a series of excellent points here. Most of this I’ve also considered which is why I stay away from certain real estate markets with the PS investments I’ve chosen. There is some detail in the write-ups on the deals that touches on the experience of the folks doing the fix-and-flip or fix-and-lease and I also take that into consideration. Several months ago, there was one where it said it was the Borrowers’ first real estate investment. Needless to say, I cancelled that one.

I do think that the bigger picture is important. This segment of the bridge lending market isn’t dealing with large developers who have access to cheaper capital. They are people like you are, on the ground in that market scouring for properties that are distressed and have upside potential. It’s akin to finding a needle in a haystack and the short window where the market is inefficient is where the bridge lenders fit. Most of the loans require a pretty hefty cash injection from the Borrowers which makes me more comfortable. Like most folks are saying, time will only tell if this experiment makes sense or not.

All our income is used to pay our bills and I am a long way off ever being an investor as would prefer to be mortgage free first. Likely in the future I will have some excess income to invest. I’m not sure how I feel about funding loans to buy and improve real estate investment when there are people who would like to own their own home but are struggling to become home owners. This is not a complaint or insult but a real inner conflict for me and wonder how people feel when they are faced with making investment choices.

I think we need to re-think our American ideal of home ownership. Sure it is still generally a good thing but frankly in many markets is just simply isn’t possible anymore. In most coastal cities the market has matured to a point where demand outpaces supply and so prices begin to skyrocket. This isn’t so much a failing of the system but rather just a natural progression of the market. In this scenario I think we have to drasticially re-think how to “invest” in real estate when most of us probably will never truly be able to own even a small house. It is in this situation that I think tools like this are good for us all – they allow us to reap the benefits of property ownership (because really “home ownership” is just a combination of good property benefits plus all the warm fuzzy non-essential feelings that come with having a yard for our 1.8 children to frolic in while we stare at our mobile phones) while still living in the reality of being a renter.

This is sweet!
I may not be eligible, but i’m on the cusp. I dug around and noticed that they allow SD IRA withdrawels from your 401K into their SD IRA. Now, I have not done 1 bit of research or digging but, could it be possible that you could take a little chunk out of your 401K and invest into something like this without penalty? Im only 41 years old, so not sure if the 59.5 years old rule applies. Curious if anyone has any intel on this kind of idea.

I believe you would have to roll over the amount into the IRA. It may require a distribution that would need to be invested in a timely manner. Personally, I would put new money into this investment and avoid taking money out of established investments. I think this investment, like any investment, should be a part of a well diversified portfolio. However, since the monies are taxed as regular income it would be prudent to place in an IRA. I’d say invest 5-10% of net worth into account. I’m sure as this matures, defaults will happen. Like any investment, it has risks and you and your portfolio should be willing and able to take the risk.

I’m an accredited investor with Fundrise (13% average gross yield) and I also have Lendingclub notes next to my stock and REIT ETF’s.
At the end with this P2P investing you are holding debt notes; that means they are not covering inflation. A good REIT with a 7% yield and yearly rising dividends (for example HCP, OHI or OLP) is as good or better as a 10% yield with unsecured P2P notes. The main risk is not a default of a single housing/consumer credit note but a default of the issuer of the notes. If the US stock market would be at a Shiller CAPE of 16 or below I would not even think to have 20% of my net worth in those Funrise+Lending Club you name it notes. At current stock market valuations, it’s a nice diversification but not much more. Buy some good REITS and you have nearly the same long-term net yield and a lower default risk. Taxation is the same but REITS are covering inflation (and the inflation part is not taxed) and their balance sheet/business model is bullet proofed. Marcel

Wow, this sounds totally off the mark for MMM. So, I am going to invest in RE “flips” where the investors take most of the risks? Real estate flipping is risky, you are either going to make a great profit or lose your shirt. The idea of taking all or most of the risk, with no upside potential other than the fixed interest rate does not sound smart. Sorry, and I am a big MMM fan on most topics – but this one has me scratching my head.

I typoed the email address (one character off my own, the dangers of trying engage on a smart phone with a TEENY screen and keyboard. Sorry Paulo in Argentina. You must be really confused). But I digress.

“Wow, this sounds totally off the mark for MMM.”
My thoughts too, but for different reasons. I tuned into the MMM blog because he/it/they seemed originally to be espousing, for the everyday person, the virtues (both financial and emotional) of simple living.

Yeah, I get it in some respects. MMM has definitely made a go at real estate investing, and I would definitely back one of HIS projects. But this gets you very far removed from the person with which you are investing. You are counting on the company to do a lot of the research in terms of the Loan to Value, potential success rate, company viability, etc. One of the similar firms, Lending Club, just had a big CEO departure and fraud allegations. I agree, lets focus on simple living and simple investing.

I think of this more as another way of diversifying investments beyond VTSAX, in line with LC, Prosper, and investing in REITs. I use Upstart for the same reason – I both like the idea of making it easier for people to get out of horrible credit card debt, like their alternative loan risk model, and view it as a worthwhile way to add a bit of diversity to my investments. (I can’t do LC because Pennsylvania. But upstart’s limited to accredited investors, so it was an option.) But I do limit it mostly to toy money.

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